Puja Mehra, Prachi Priya, and Abhijnan Rej
The COVID-19 pandemic continues to adversely impact lives, livelihoods, and the economy in India, with a devastating second wave wreaking havoc even as the threat of a third wave looms large. Rising uncertainty has reduced consumer and business confidence. Growth over the two-year period FY20 to FY22 could be zero percent or negative. This follows an economic slowdown during the three years preceding the pandemic. With investments and trade performance weak, the Indian economy was firing mainly on consumption, which the first and second waves of the pandemic have hit badly.
A new DRI Monthly Report examines the factors that are likely to shape the recovery from the impact of the pandemic and its interaction with existing structural economic bottlenecks. The report is based on interviews with eight senior experts on the Indian economy as well as secondary research.
The report identifies the following risks as looming large over the Indian economy in the short and medium terms. Access the full report, which deep-dives into each of the issues identified below, here.
Short Term (FY 2022)
#1 A Severe Pandemic Third Wave
A severe third wave of the COVID-19 pandemic, which has been mismanaged by the central and state governments, puts the Indian economy in uncharted territory. Experts expressed apprehensions about the emergence of new and more virulent strains of the novel coronavirus, which might necessitate the re-imposition of lockdowns across the country, leading to a further (and possibly dramatic) reduction in growth estimates and adding to dampening demand. Complicating matters further is the fact that, as one economist noted, it is not known how consumers and households will react following the end of the second wave: How would household savings be impacted? Will consumers be reticent about spending again?
#2 Pressure on Banking Sector
The potential adverse impact of the pandemic, especially if a severe third wave surfaces, on India’s already stressed banking sector, which is saddled with legacy non-performing assets, remains of concern. Experts fear a fresh wave of bankruptcies that add stress to the books of commercial banks, and that loan repayment schedules could be further delayed. India’s non-banking financial sector – which has traditionally lent to small and medium enterprises likely to be most affected by first and second wave lockdowns – could also contribute to the stress on the banks that lend to them. Similar fears hold about how pressure on microfinance institutions could systemically affect the banking sector.
#3 Policy Uncertainty
Since his election for a first term in 2014, Indian Prime Minister Narendra Modi has demonstrated a penchant for dramatic policy moves without factoring in their second and higher-order effects. His sudden 2016 decision to scrap 86 percent of Indian currency notes with a few hours’ notice to the public serves as case in point, along with a sudden imposition of a nationwide lockdown during the first wave of the pandemic last year without adequately calculating its economic and social costs. As such, a climate of policy uncertainty persists in India that became once again visible through Modi’s flip-flopping vaccination policy over the past few months. Private-sector investors continue to be apprehensive about policy uncertainty. This is an addition to other pandemic-related stressors to the economy which, in turn, sit on top of pre-existing problems (which an expert described as the Indian economy’s comorbidities).
#4 Inflationary Pressure
Rising inflation could pose a serious risk though, as one expert maintained, while inflationary pressure could increase because of supply dislocations, policymakers should see through them for now, unless price pressures seep into the rest of the economy. Another expert pointed out the added problem of inflation “imported” from advanced economies, especially with the United States’ money-printing spree to stimulate the U.S. economy. They also maintained that should state and central governments continue to widen their cash support programs, it will also add to inflationary pressure. The possibility of a “stagflationary scenario,” with high inflation and unemployment, cannot be ruled out.
#5 Uncertainty about Private Sector Investment
Private sector investment plans are also likely to be affected, given uncertainty about consumer behavior. One expert noted that the extent of the shock to consumers from the second wave will become visible in the second quarter (July-September 2021).
Medium Term (Three-Five Years)
#1 Deepening Jobs Crisis
The key medium-term risk to the Indian economy remains a deepening employment crisis, which prevents India from utilizing its favorable demographics. To be sure, this problem was present even before the COVID-19 pandemic hit, but the first two waves – and potentially a third – have severely aggravated it, with lasting impact. Meanwhile, with the economy already under considerable stress, the major factor market reforms and corrections needed to tackle the problem remain both economically and politically unfeasible. Experts also pointed out the risk from a growing digital divide in the country and the effect of the pandemic on India’s education system – and its cumulative impact on jobs and livelihoods.
#2 Rising Protectionism
Last year, Modi unveiled an ambitious “AtmaNirbhar Bharat” (self-reliant India) campaign, which many experts fear will compound India’s growing protectionism. While some experts point to the growth in India’s exports, others fear that further protectionist measures could damage India’s international trade. As one expert pointed out, there is a real risk that the Modi government will misread the lessons of the pandemic and put further autarkic measures in place. Members of Modi’s cabinet have already publicly expressed their misgivings about India’s economic liberalization program initiated almost exactly three decades ago. If geopolitical tensions with China – India’s largest trading partner in goods – continue to rise, it could dent trade with that country. Meanwhile, New Delhi continues to struggle to conclude free-trade agreements with major Western economies.
#3 Worsening Fiscal Outlook
India’s government debt to GDP ratio continues to grow, standing at 90 percent in April this year. At the same time, the country’s inability to control its fiscal deficit and the composition of its current account deficit continue to pose concerns. Central government finances are also likely to be strained by the costs of universal COVID-19 vaccination. Possible further tax relief, a dip in tax collections due to the impact of the pandemic on GDP and incomes, or delayed compliance as post-pandemic stimulus are added stressors in this regard.
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